In my last blog entry, I described the awesome power of the U.S. President to under an “economic emergency.” That authority includes, among other measures, the power to restrict or even prohibit the transfer of dollars outside the United States.
One possible scenario for emergency economic controls would be a run on the U.S. dollar. That may not seem likely given that the dollar has sharply appreciated in recent months. However, that appreciation may not continue given the enormous sums of money the U.S. government has spent trying to deal with the ongoing and deepening financial crisis: over $1 trillion since the beginning of 2008, and increasing by hundreds of billions of dollars each month.
At the end of 2007, the world's central banks held an estimated US$3.4 trillion in U.S. dollar reserves. China holds the largest share—about US$1 trillion—followed by Japan with US$700 billion or so.
In today's digital marketplace, dollar owners don’t hold them in cash, but in electronic form; blips on a computer screen. Traders can buy (and sell) dollars by the billions at the click of a mouse.
As long as the value of the dollar is relatively stable, central banks are content holding trillions of them. They earn interest on them by using them to purchase dollar-denominated assets such as U.S. Treasury bills. However, one or more of the central banks holding a few hundred billion dollars—or more—could suddenly decide to convert them to gold, or to other currencies. Or a hedge fund manager could use options and derivatives to make a massive bet against the dollar, hoping to profit on the dollar's collapse.
Whichever way it begins, a dollar selling panic would be expressed in many different ways. A dollar sell-off would devastate foreign investors with a future claim denominated in dollars. The value of dollar-denominated bonds and other financial claims would plummet as investors rush for the exits.
A dollar panic would also seriously restrict all dollar-denominated international trade and commerce. For instance, foreign persons owning property scheduled for future delivery to the United States (e.g., oil supertankers with cargos worth US$200 million or more) would likely refuse to accept payment in dollars.
Faced with the worst financial crisis in its 200-year history, the U.S. government would certainly impose emergency financial controls. Indeed, the public will demand that it do so. And President Bush (or his successor) has many tools at his disposal to deal with such a crisis. Besides those I mentioned in Part I, they include:
- Foreign exchange controls restricting the ability to convert U.S. dollars to other currencies
- Restriction on foreign investors seeking to repatriate dollar profits or investments to their home countries
- Restrictions on foreign investment as U.S. property become much less expensive in foreign currency terms. (The controversy over the proposed purchase by a Dubai company of operating rights for several U.S. ports will seem mild by comparison).
- Restrictions on international travel
- Rationing of imported goods, especially gasoline and oi
This isn't a prediction, and I hope this scenario never develops. But given the turmoil on the international financial markets, anything is possible.
How can you adapt your portfolio to the ongoing economic emergency, and the prospect of a dollar selling panic? My next installment will provide several suggestions you can put into place immediately.
Copyright © 2008 by Mark Nestmann
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